Does availability of credit increase or decrease bankruptcy filings? Both!

Do more people file bankruptcy when credit is available, or rather when credit gets squeezed?

Law Professor Robert Lawless argues:

“The long-term growth in U.S. consumer bankruptcies closely tracks the long-term growth in U.S. consumer debt. When the financial crisis hit, consumer credit dried up, and outstanding consumer debt experienced unprecedented declines. There are fewer reasons to file bankruptcy today because there was less borrowing two to three years ago.

“Consumer debt also has a profound but perhaps counter-intuitive short-term effect on consumer bankruptcy rates. In the short-run, a decline in consumer credit will lead to a bump in consumer bankruptcy filings. As people run out of options–as they become less able to put this month’s grocery or utility bills on a credit card–bankruptcy becomes a more attractive option. People can and will continue to borrow to stave off the day of reckoning. If a lender is willing to extend credit, further borrowing is a rational decision.”

Sounds sensible to me: 1) Most debt happens because of credit availability, so more bankruptcies happen when there more credit granted. (The exceptions are involuntary debts like lawsuits resulting from personal injuries or other disputes.) 2) Those with debt problems avoid filing bankruptcy if they can, so loose credit means some of them can avoid, or at least postpone, filing bankruptcy

BTW, if you’re interested in more of what Bob Lawless has to say, he is a regular blogging contributor to Credit Slips, “A Discussion on Credit, Finance and Bankruptcy.” It’s one of the best in the business on this set of topics.